How does cap-and-trade work?

• A. A cap sets total emissions; permits are allocated and can be traded, creating a market price for pollution.
• B. A cap imposes a tax on emissions that increases with quantity emitted.
• C. A cap bans emissions outright with no allowances.
• D. A cap uses subsidies to encourage clean technologies.

Answer: (A)

Cap-and-trade fixes the total amount of pollution and creates a market for the rights to emit. The government sets a cap on overall emissions and issues a limited number of permits, each allowing a certain amount of pollution. Firms must hold enough permits to cover their emissions, and these permits can be bought and sold. This creates a market price for pollution, rewarding those who can cut emissions cheaply by selling permits and encouraging others to reduce if the price is high enough. The result is a cost-effective path to lower overall emissions: a tighter cap pushes the permit price up, inducing more reductions; a looser cap lowers the price and fewer reductions are needed. The approach blends a clear quantity limit with a price signal.

The other options describe different tools: a tax on emissions, rather than a tradeable permit system; a blanket ban with no allowances; or subsidies to promote clean technology. These are not cap-and-trade.